Difference between tax evasion and tax avoidance

The Direct Taxes Enquiry Committee (Wanchoo Committee) has tried to draw a distinction between the two items in the following words.

“The distinction between ‘evasion’ and ‘avoidance’, therefore, is largely dependent on the difference in methods of escape resorted to. Some are instances of merely availing, strictly in accordance with law, the tax exemptions or tax privileges offered by the government. Others are maneuvers involving an element of deceit, misrepresentation of facts, falsification of accounting calculations or downright fraud. The first represents what is truly tax planning, the latter tax evasion. However, between these two extremes, there lies a vast domain for selecting a variety of methods which, though technically satisfying the requirements of law, in fact circumvent it with a view to eliminate or reduce tax burden. It is these methods which constitute “tax avoidance”.

Substance versus form

Where form prevailed: A firm transferred its business assets to a company formed for its purposes. The same business was carried by the company consisting of the erstwhile partners as its shareholders. The Income-tax Officer sought to withdraw the depreciation allowed (the difference between sale price and written-down value) of machinery. Tribunal and High Court held that there was change only in the form of ownership as persons behind both firm and company were the same. Supreme Court held that legal form should prevail and restored the order of Income-tax Officer. This is a case where the form came to the assistance of revenue CIT v. B.M. Kharwar (1969) 72 ITR 603 (Supreme Court).

Where substance prevailed: 

• The assessee received compensation ostensibly paid for premature termination of managing agency and claimed that the receipt was not liable to tax as a capital receipt. The Supreme Court upheld the action of authorities in ignoring the legal façade which merely disguised the real intention between the parties to cloak payment of income nature as a capital one – Juggilal Kamlapat v. CIT (1969) 73 ITR 702 (Supreme Court). 

• Certain shares were held in the name of others, but the deceased was the real owner of the shares as was found with reference to evidence. The High Court had held that the shares were not includible in the estate of the deceased as they were not in his name. The Supreme Court pointed out that, in substance, the deceased was the owner though only beneficially and upheld the inclusion for estate duty purposes – CED v. Aloke Mitra (1980) 126 ITR 599 (Supreme Court).